In what is probably going to go down as one of the largest and most profitable acts of trolling ever executed, beleaguered retailer GameStop found itself at the center of a battle between regular everyday traders and some of Wall Street’s biggest hedge funds. Though the saga hasn’t ended as of press, early estimates peg total losses for those aforementioned funds at some $70 billion. So how did a company that many people thought wasn’t going anywhere end up costing people tons of money? It all has to do with something called short selling.
At its core, short selling is a market bet that a stock or company is going to decline in value, possibly even fail. To keep things simple, if the opposite happens, the people who take a short position have to cover the disparity in the current value of the stock and the initial amount they exercised as a short. One prominent Wall Street firm, Melvin Capital, had placed a large short bet on GameStop and others followed as is often the case. At one point, the value of shorts equaled 140% of the total value of outstanding shares of GameStop on the market. How this is possible and why short selling is even allowed in the first place have come front and center because of this GameStop fiasco and you’ll shortly see why. A Reddit forum called Wall Street Bets, it is alleged, has worked to drive up the price of GameStop stock resulting in what is called a “short squeeze” for the funds that had taken out such a position.
A short squeeze is what happens when a person or firm has to cover the increase in the value of a security that it had bet would decrease. Because of the amazing multiples posted by GameStop stock, this short squeeze, in the billions upon billions, is so large it could prove the ruin of some traders that had taken a position on GME. Increasing 685% in 2021 alone, the amount of money firms have to post to cover the rise in value is still difficult to estimate. This is probably why some are advocating for a freeze on the trade of GameStop (as well as some other shorts that are facing a squeeze such as Nokia and Blackberry, oddly enough) because, if the stock keeps going up in value, even more carnage could be the result on Wall Street. Beyond the immediate situation, the move by Robinhood and some other trading firms to freeze the buying of GameStop securities is being met with nothing less than outrage and condemnation and, for once, from all sides of the political spectrum in the United States.
After all, most allege, when a regular person loses everything that is just how the game goes, but when Wall Street does it is a tragedy. Further, the fact that short selling has made billions for many traders over history and yet serves a functional yet definitely questionable purpose highlights the fact that, when the tables are seemingly turned, Wall Street would rather keep its own scheme going than let others in on the action. As for where all of this is headed is anyone’s best guest but we’ll keep you posted.
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